By the BF Staff
From the March/April 2021 Issue
Before the coronavirus pandemic emerged, it didn’t seem like anything could upend the relentless paradigm of globalization: a global market fed by goods manufactured at lower cost in developing nations, with supply chains spanning several continents and all of it moved around by world-class logistics at higher and higher volumes.
What a difference a year can make. The scramble at the beginning of 2020 to cobble together new supply chains for personal protection equipment and other vital medical supplies in the U.S. was a revelation to industry leaders who now wonder whether they can count on overseas supply chains for key components of their products.
Bringing supply chains home—also known as local for local—was already trending before the pandemic erupted, as the once-symbiotic economic relationship between China and the United States began to unravel. Rising Chinese labor costs and growing security concerns over a reliance on China for sensitive electronic components accelerated reshoring, with manufacturing jobs from reshoring outpacing the number of jobs created by foreign direct investment last year. Now, President Biden says he wants to wipe out America’s trade deficit by bringing 5 million manufacturing jobs back to the U.S.
In this report, experts in the U.S. and Canada tell us how they’re rethinking the global supply chain and preparing to bring manufacturing home.
SUPPLY CHAIN OPPORTUNITIES IN CANADA: CLOSER. GREENER. STRONGER.
The COVID-19 pandemic exposed significant risks to the predominant 21st century business model of global supply chains in which commercial decisions were based primarily on low-cost production and sophisticated logistics.
Two-thirds of global chief executives say they have had to rethink their supply chain in the wake of COVID-19, according to KPMG LLP and its CEO surveys. KPMG found the top five reasons global CEOs were rethinking their supply chains was to become more agile in response to changing customer needs (32 percent); to become more robust in the event of a natural world disaster (22 percent); pressure from customers and communities to bring production closer to home (19 percent); to reduce supply chain risk exposure (10 percent); and pressure from governments to bring production closer to home (9 percent).
In the midst of this evolving mindset, national governments and global companies are rethinking many widely held, conventional views about supply chains and are adopting new approaches. Out of this transformation comes opportunities for investment in supply chains. And there is no better place to invest than Canada for stable, secure prospects in supply chains that are critical to the global economic recovery from the pandemic.
Why Canada for supply chain investments?
First, an illustrative example: In March 2020, Canada produced just ½ of 1 percent of its own personal protective equipment (PPE). By October 2020, Canada produced 70 percent of its own PPE. By any account, that is a remarkably rapid and dramatic transformation.
In the case of PPE, Canada’s actions were born of the necessity to produce safe and reliable life-saving products free from the risk of supply chain constraints or geopolitical pressures. The retooling of production on short notice is an example of a transformation that can be replicated in other sectors of the Canadian economy.
Global companies are now reviewing operations and considering next investments in strategic locations with stable business environments. While global supply chains will not disappear when COVID-19 recedes, more resilient and sustainable production systems will become a priority for executives at international companies pursuing the next big growth opportunities.
Three supply chains with potential for investment coming out of COVID-19 in Canada are Advanced Manufacturing, Agribusiness and Clean Tech. KPMG identified significant opportunities for investors in Canada’s supply chains in a report commissioned for Invest in Canada, Advantage Canada: Reshaping Supply Chain Investment Opportunities After COVID-19.
Canada’s dynamic supply chain opportunities build on existing advantages that include a reputation as an open economy and stable democracy with a sound banking system and a strong commitment to the rule of law, as well as unmatched market access, exceptional talent and the ability to attract skilled people from across the globe.
While some countries turn inward out of concerns and uncertainty about multi-lateralism and globalization, Canada has taken the opposite approach. Increased trade flows and investment are crucial factors on the road to recovery, especially in key sectors that have been disrupted by the pandemic.
What are the growth sectors?
Agribusiness, which covers agriculture, forestry, fishing and food production, is perhaps the clearest of Canada’s supply chain stories. Innovative technology known as agri-tech plays an increasingly important role in improving the yield, profitability and efficiency of businesses in this sector. Canada is already a significant producer, contributing over $110 billion annually to its GDP. As supply chains shorten and become more regionalized, FDI opportunities will be created.
Food safety will be an essential component for consumers, so investments in packaging and tracing will have high demand in a post-COVID-19 world. Canada has an integrated and secure farm-to-fork food system that is already oriented toward exports. In combination with high levels of trust in food quality and safety, agribusiness represents a standout opportunity for investors.
Plant-based proteins are a market segment in which Canada is already a recognized world leader. France-based Roquette has invested $600 million in the world’s largest pea-protein facility in Portage la Prairie, Manitoba, which is set to reach full production capacity in early 2022. Agrocorp, headquartered in Singapore, completed work in 2019 on a pea protein extraction plant project in Cut Knife, Saskatchewan. In late 2020, U.S.-based Ingredion Incorporated took full ownership of Verdient Foods Inc., located in Vanscoy, Saskatchewan, to produce specialty pulse-based protein ingredients. This fast-growing industry continues to attract investment and is supported through the government’s Protein Industries Supercluster Initiative.
Advanced manufacturing covers multiple sectors, including automotive, aerospace, chemical, pharmaceuticals, medical devices, electronics and plastics. Canada has a singular strategic advantage for international investors due to its proximity to the U.S. market. In addition, a trusted Made-in-Canada brand and an established manufacturing sector ripe for retooling to industry 4.0 create investment opportunities in advanced manufacturing.
The trend toward clean technologies is producing opportunities for advanced manufacturing investment in Canada, especially in transportation fleets (buses, trucks and marine shipping). The Big 3 North American automakers have announced plans to transform plants located in Ontario away from gasoline-powered vehicle production to automobiles powered by batteries and electricity. Nova Bus (part of the Volvo Group) is expanding one of its Quebec plants to produce electric buses, hybrid electric buses, high-capacity vehicles and integrated intelligent transport.
Clean tech is not limited to transport vehicles; it reflects an industry focused on applying innovative technologies that reduce carbon emissions across the energy sector. Clean tech includes renewable energies such as wind and solar, but it also improves the efficiency of existing oil and gas production and more sustainable use of waste. Clean tech includes the fast-growing ocean energy sector, which includes thermal, wave and tidal generation.
In its report, KPMG describes Canada as a “playground for Clean Tech” with a wide range of investment opportunities. The leading opportunity for investment in clean tech is the transition of the natural resources industry to clean energy uses. Existing energy systems are ripe for transition and cross-sectoral innovation can be of widespread benefit to many industries. Canadian governments are committed to lowering greenhouse gas (GHG) emissions and reducing the impact of climate change.
Canada has historically been a leader in the hydrogen industry. In British Columbia, Ballard Power Systems has a four-decade record of developing innovative fuel cell products, and Mercedes-Benz Canada Fuel Cell Division is playing a key role in the implementation of the next Fuel Cell Car Series.
In December 2020, the Canadian government released a hydrogen strategy to position Canada as a global hub of hydrogen and fuel cell innovation for years to come. Canada has all the ingredients necessary to develop a competitive and sustainable hydrogen economy. Each region of the country has unique resources to produce hydrogen and to supply a growing export market.
Canada’s mining sector also represents an important contributor to shaping the clean tech sector through supply of key materials such as uranium for nuclear energy; iron and neodymium for wind turbines; and nickel, lithium, cobalt and graphite for batteries to power electric vehicles.
Canada’s commitment to the electric vehicle industry is powered by an integrated “mines to mobility” strategy to develop a supply chain for EV batteries. From natural resource extraction of critical minerals, through battery production, and concluding with safe recycling and disposal, Canada presents opportunities for investment across the full length of the supply chain. The growing scale of the industry enables investors to shape the development of the sector with early-stage investment.
The increasing relevance of ESG
Environmental, social and governance (ESG), combined with climate change, will be defining lenses through which investments will be viewed for decades to come. ESG is directly linked to companies’ achieving their project and financial goals. Consumers want to know that the products and services they are buying are sourced in jurisdictions that practice ESG principles.
RESHORING: BRINGING MORE MANUFACTURING JOBS TO THE U.S. THAN FDI
The disruption of the global supply chain for critically needed medical supplies during the pandemic—and the ongoing decoupling of the symbiotic manufacturing, financial and trading relationship between the United States and the People’s Republic of China—have accelerated the reshoring of manufacturing to the United States and given new momentum to the trend toward localization of supply chains.
[Early in the pandemic, China diverted exports of surgical masks and other PPE to its local governments and hospitals, leaving foreign purchasers without supplies. Along with India, China is also a major source for the active ingredients that go into making drugs, including antibiotics and pain medicines. China is the largest supplier of rare earth minerals that are critical to manufacturing electronics and weapons components; in the past it threatened to ban the export of rare earths, and, more recently, has proposed new export curbs for these vital materials.]
Disruptions in the global movement of critical goods during the pandemic—including a shortage of semiconductor chips that has forced large portions of U.S. automotive production to shut down—prompted President Biden last month to issue an executive order requiring his administration to review critical supply chains with the aim of bolstering U.S. manufacturing. Biden ordered yearlong reviews of six sectors and a 100-day review of four classes of products where American manufacturers rely on imports: semiconductors, high-capacity batteries, pharmaceuticals and their active ingredients, and critical minerals and strategic materials, like rare earths. Additional actions to strengthen those supply chains would depend on the vulnerabilities that were identified, officials said.
“We are going to get out of the business of reacting to supply chain crises as they arise and get into the business of preventing future supply chain problems,” Peter Harrell, the White House’s senior director for international economics and competitiveness, told reporters at a Feb. 24 news briefing.
Coincidentally, Feb. 24 also was the date of our BF Webinar Series presentation of Bringing Your Supply Chain Home, with Reshoring Initiative Founder and CEO Harry Moser. The Reshoring Initiative made major news in November, when it reported that the number of U.S. manufacturing jobs that resulted from reshoring in 2020 had surged past the total generated by foreign direct investment for the first time in seven years.
According to Reshoring Initiative estimates, nearly 69,000 manufacturing jobs were reshored to the U.S. in 2020, while foreign direct investment only yielded about 42,000 manufacturing jobs in the U.S. The long-term trend put this shift in starker terms: after moving in tandem for almost a decade, the level of reshored jobs surged up by 45 percent while the FDI-related jobs went down by 40 percent. Moser said that the pandemic was cited as the primary motivation for reshoring decisions by 60 percent of respondents to Reshoring Initiative surveys; a June 2020 survey of 750 North American manufacturing firms found 69 percent were likely or extremely likely to reshore overseas operations.
“A big part of the surge in reshoring in 2020 was COVID-related, involving PPE. Hundreds of companies have started up in the U.S. to make masks, gloves and gowns, and companies are beginning to make pharmaceuticals that were dependent on overseas suppliers. But many companies [are now saying] I saw what happened in the medical field, we’re just as dependent as they are [on overseas suppliers], that could happen to us, so let’s bring some of our sourcing back to the United States,” Moser said.
CAUSE AND EFFECT BETWEEN TRADE DEFICITS AND THE REDUCTION IN U.S. MANUFACTURING EMPLOYMENT
From 1970 until the end of the Great Recession in the middle of the last decade, manufacturing’s percentage of U.S. employment plummeted from 27 percent and bottomed out at 9 percent.
Although it’s hard to believe in 2021 that the United States’ balance of trade ever ran a surplus in our favor, that was the case until the middle of the 1970s. In the 1980s, U.S. trade deficits began to balloon as manufacturing began a mass migration to cheaper labor markets overseas (primarily in Asia) and U.S. consumers welcomed lower-priced goods made by China and other foreign producers. In recent years, the deficit in the U.S. trade balance has averaged about $800 billion annually.
As Moser starkly illustrated during his presentation, the decline in U.S. manufacturing jobs corresponded closely to the growth of the U.S. trade deficit, with imports far exceeding exports. “There’s a very high correlation, actually a very clear cause and effect [between the trade imbalance and the drop in U.S. manufacturing employment]. Most economists who go back and study this conclude that the largest cause of drop in U.S. manufacturing employment was due to offshoring,” Moser said.
A key factor now tilting supply chain decisions to reshoring has been consistently rising labor costs in China. Chinese wages have risen 10-15 percent a year during the first two decades of the new century. Moser attributes this to a labor shortage, resulting from the Chinese government’s one child policy, which prohibited parents from having more than one child.
“The Chinese workforce is dropping at a rate of 2-3 million per year. The supply of labor is going down while the demand goes up because they’ve had phenomenal growth, therefore the price of labor goes up.”
The labor cost (in U.S. dollars) for Chinese products is now five times higher than it was 20 years ago.
“Work was starting to flow out of China even before the pandemic and the trade war,” Moser said. “The trade war and COVID have accelerated that trend.”
Productivity also has become a key driver of reshoring decisions, with increased use of automation in the U.S. helping to offset higher labor costs.
Moser said that “nearshoring”—bringing manufacturing back from China and relocating it to Mexico—is a better outcome than leaving these jobs overseas because U.S. imports from Mexico have an estimated 40 percent U.S. content, while imports from China only contain about five percent U.S. content.
In several forums, Moser has stressed that restoring U.S. competitiveness will take much more than rising labor costs in China. He says U.S. costs versus offshore competition needs to be reduced by 20 percent. We need a lower dollar to spur exports and we need to encourage more students to pursue engineering or STEM-oriented degrees.
Capital will flow to jurisdictions, sectors and individual companies that understand and enact policies that respect ESG and that will be resilient to climate disruption.
In recent years, Canada has attracted significant investments, in part because investors see a commitment to ESG principles and to addressing climate change. As ESG becomes more ingrained in supply chains following the pandemic, Canada can build on this strong foundation to become even more attractive as an investment destination.
Looking beyond the pandemic to greater prosperity
Canada has shown its resilience during COVID-19 and is now well-positioned to help shape a once-in-a-generation supply chain transformation now underway. Investors can leverage Canada’s natural strengths: market access, stability and security; a highly educated workforce; and a positive “Canada brand.” Existing supply chains can be rescaled to adapt to changes in demand and customer preferences, and upscaled to utilize cutting-edge processes and technologies as the world emerges from the COVID-19 pandemic.
To request your copy of the KPMG Advantage Canada report on supply chain investment opportunities, or to learn more about Canadian opportunities, please contact an Investor Services team member at Invest in Canada.